Fukui's final meeting won't bring rate change

But political stalemate holds up Bank of Japan chief's successor

By

ChrisOliver

HONG KONG (MarketWatch) -- Bank of Japan Governor Toshihiko Fukui will preside over his final policy board meeting in Tokyo from Thursday, with the two-day event expected to yield no change to interest rates.

But drama continues to unfold outside the meeting, as a political deadlock increases the chances of a surprise announcement on Fukui's successor -- or even a period where the central bank of the world's second-largest economy has no governor at all.

Fukui and the others on the nine-member policy board are expected to leave the overnight call rate at 0.5%, the lowest benchmark interest rate among Group of Seven nations.

The meeting will be the 72-year-old Fukui's last before his five-year term expires March 19. Deputy Governor Kazumasa Iwata will also step down when his term expires this month.

"Uncertainty is now getting bigger and bigger," said Credit Suisse economist Hiromichi Shirakawa in Tokyo, referring to who takes on the top central banker's job next.

Deputy Governor Toshiro Muto, whose five-year term also expires later this month, was widely cited in Japanese press reports as the government's preferred successor.

Muto's appointment to head up the central bank was considered a near certainty last year before control of the upper house of parliament passed to the opposition Democratic Party of Japan (DPJ) in July.

Prime Minister Yasuo Fukuda's ruling coalition and the DPJ fell out over the 2008 budget, casting a shadow over Muto's appointment.

There's little to suggest a consensus is forming on a suitable candidate, although analysts won't rule out the possibility of an announcement this week as the government maneuvers to shore up investor confidence as Japan's stock prices wither.

The 225-component Nikkei Stock Average has declined about 15% since the start of the year and is down about 29% from its high in July last year.

"At a time when uncertainty is mounting again in the equity markets, there is no ruling out the possibility that this situation will create a reason to sell Japanese equities," said Barclay's Capital strategist Chotaro Morita in Tokyo. Expanded global coverage.

He added the markets could begin to discount rate cuts if the growing unease over leadership at the bank sparks another sharp drop in financial markets, such as the one seen in January.

As Japan's economy teeters and downside risks rise in the global economy, critics say the stalemate couldn't come at a worse time.

"In the worst-case scenario, a vacancy at the top would paralyze the central bank's policymaking. What then becomes of grave concern is the BOJ's ability to work closely with other central banks, especially at a time when such cooperation has become vital in the wake of the U.S. subprime fallout," wrote Naoaki Okabe, senior executive editor of The Nikkei, in an editorial published on the business daily's Web site dated Thursday morning.

"For lawmakers and political parties to turn the appointment process for a central bank leader into a circus can only be summed up as the ultimate folly," Okabe said.

Steady as she goes

The BOJ's nine-member board voted unanimously to hold interest rates unchanged last month. In its February assessment of the economy, the bank said the economic recovery remains basically intact, but noted momentum had weakened in the wake of a sharp drop in housing investment. It noted the outlook for factory output had softened since January, but is likely to pick up as housing improves.

'It shouldn't meaningfully impact the steady-as-goes we expect to see from the BoJ this year.'
Glenn Maguire, Societe Generale

February's decision marked the third-straight month the policy board agreed unanimously to keep rates unchanged, ending six consecutive meetings to November where some members called for higher rates.

Analysts said the communiqués by the central bank showed a significant step down from its earlier assessments of the economy, as underpinned by a cycle of growth in production income and spending.

"Official communication says gradual policy adjustment is necessary, but really through verbal communication they have been toning that down and really emphasizing the downsized risks to growth," said Lehman Brothers' economist Hiroshi Shiraishi in Tokyo. "In a sense they have brought their policy stance closer to neutral already."

On Tuesday the future's markets were pricing in a zero percent chance of a rate hike on Friday. In the next 12 months, the futures markets expect 0.1-percentage point of rate cuts, according to a calculation by Credit Suisse that uses market-implied interest rate pricing.

In January, the BOJ lowered its assessment on four of Japan's nine regional economies, the largest number of regional areas to be downgraded since the introduction of the report in April 2005.

In speeches following that report, Fukui reiterated his view that Japan's economy had weakened, while also noting the credit crisis had a greater-than-expected impact on Japan's financial institutions.

Recent government data showed Japanese factory production fell 2% in January from the previous month. The declines likely mean factory output in the January to March period will contract against the previous quarter, marking the first quarter-on-quarter decline in a year.

Another worry for policy makers is slowing exports. January exports to the U.S. fell 3.2% in value against the year-earlier period, marking the fifth straight month of declines.

But other recent data pointed to a modest recovery in consumer spending, with household spending rising 3.6% on a nationwide basis in January on year.

Little disagreement over policy

Central bank watchers say there's little disagreement over the policy approaches among the potential candidates, with most of those short-listed expected to follow Fukui's stance of over the past year of holding interest rates steady.

"It shouldn't meaningfully impact the steady-as-goes we expect to see from the BOJ this year," said Glenn Maguire, Societe Generale's chief Asia Pacific economist.

Technically, there's no urgent need to forge an appointment before Fukui leaves office. Under the central bank's charter, other board members can fill the governor's duties, but whether these replacements have voting rights at policy board meetings is unclear.

Some analysts say the unresolved leadership question could have an impact on the BOJ's target for price stabilization. The central bank currently targets an annual rise in consumer prices of zero to 2%, with most board members naming a 1% rise as ideal. A leadership vacuum could give more sway to board members calling for a range of 1% to 2 % ahead of a formal review of the price target in April.

Nominees to the BOJ executive, which include the governorship and two deputies, will be selected by the Cabinet and put forward to both the upper and lower houses of parliament for approval. Under previous administrations, BOJ executive appointments were decided in private high-level talks, with passage of bills authorizing the appointments little more than a formality as governments of the day controlled a majority in both houses of parliament.

Opposition to a Muto nomination hardened after last week's 2008 fiscal budget was bullied through parliament using the lower houses' superior numbers, instead of allowing more time for debate.

"The DPJ is using this as a policy card to get concessions for other issues like budget and tax reforms," said Lehman Brothers' Shiraishi, referring to the opposition's stance against a government-friendly appointment.

The upper chamber has the power to block nominations for public officials under a "sudden death" system, which essentially can derail an unpopular nomination. The process mostly likely means Fukuda's government must get the opposition to sign off on nominations to fill the three upcoming vacancies on the central bank's executive.

With control over the chambers now split, nominees will face more public scrutiny.

"This time around something akin to the U.S. senate's confirmation hearings is likely to occur," said Maguire.

Muto, 65, joined the Ministry of Finance shortly after completing his legal studies at Tokyo University in 1966, eventually rising to the position of vice minister in 2000, the highest level that may be occupied by a civil servant. Muto was nominated to the Bank of Japan's policy board in 2003 and has voted in line with consensus policy throughout his term.

As an ex-finance ministry official Muto is viewed as aligned closely with the government's fiscal goals and inclined to pursue a slightly less hawkish monetary policy, analysts say.

Another leading candidate is Yutaka Yamaguchi, 67, who served a five-term as deputy governor until 2003.

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